Sunday, August 7, 2011

One sentence from Beckworth

Several studies that examine economic conditions since 1970 or since 1980 pile error upon error. They fail to compare conditions to those of a healthy economy. This leads to false conclusions. In addition, these studies examine government debt exclusively, failing to consider the greater burden on the private sector that is the debt of the private sector.

To see why Jazz was all riled up, I had to read this Beckworth post, then Beckworth's link at Cafe Hayek, and finally Hayek's internal link.

In all of that, one sentence from Beckworth stood out:

What the evidence does show is that in most cases where fiscal consolidation was accompanied by a robust recovery it happened because monetary policy was accommodative.

That idea is central to the post, titled "Fiscal Austerity Requires Monetary Liberality". From the central notion, Beckworth draws general conclusions:

Along these lines, a more general point is that the impact of any fiscal policy action--where expansionary or contractionary--depends on the stance of monetary policy... Another way of saying this is that an independent monetary policy will always dominate fiscal policy.

And from those conclusions Beckworth draws policy implications:

So if Russ Roberts is like me and wants fiscal policy consolidation that works he should really be clamoring for more monetary stimulus. Otherwise he may get more than he bargained for.

I don't think I agree with much of that. But the central notion is key.

That notion again: most cases where fiscal consolidation was accompanied by a robust recovery it happened because monetary policy was accommodative.

When I read it, it created a picture in my mind. Perhaps I can re-create the picture:

"Robust recovery" requires vigorous spending growth. Commensurate with the growth of spending, I expect to see a vigorous growth of the medium of exchange: a vigorous growth of money in circulation.

"Fiscal consolidation" spends less money into circulation. This is not conducive to a vigorous growth of money.

"Accommodative" monetary policy is conducive to vigorous money growth. So it is not surprising that Beckworth's evidence shows accommodative money growth accompanying robust recovery when fiscal expansion does not.

But there is a big difference between fiscal expansion and monetary accommodation. Fiscal expansion increases debt in the public sector. Monetary expansion increases debt in the private sector. Get the picture?
Beckworth overlooks it, in his post.
The relation between the two debts can be observed in my debt-relative graphs.

It takes a lot of time to read other people's evidence. But I'll give it a shot.

Beckworth links to Chapter 3: Will it Hurt? Macroeconomic Effects of Fiscal Consolidation from the IMF, a 32-page PDF. A quick scan of the paper turns up the following note:

Looking at History: What Is the Short-Term Impact of Fiscal Consolidation?

In this section, we examine the history of fiscal retrenchment in advanced economies over the past 30 years and evaluate the short-term effects on economic activity. The section starts by explaining how we identify periods of fiscal consolidation, and contrasts our approach to the standard approach used in previous studies. It then reports the estimated effects of fiscal consolidation, and compares our results with those based on the standard approach.

That's all very nice, and you probably didn't even notice, but this thing they call "history" looks only at the past 30 years. That takes us back to around 1980, six years after the 1974 recession, by which time it was already obvious that the economy was no longer in good shape. So this IMF study is yet another study of a completely screwed-up economy, with no "golden-age" years to serve as a benchmark.

Beckworth links next to G-24 Policy Brief No. 57, "Fiscal consolidation, growth and employment: What do we know?" a 3-page PDF.

An IMF study of 74 cases of fiscal consolidation in 20 industrialized countries over the 1970-1995 period concluded that 14 cases were ‘successful’ in the sense that they were marked by sustainable reduction (by about three percentage points over a period of three years) in the debt-to-GDP ratio as well as an increase in growth and employment creation. Second, Alesina and Ardagna study of 107 episodes of fiscal consolidation in all OECD countries in the 1970-2007, found 27 cases of fiscal consolidation with growth. Thus, the probability of a successful fiscal consolidation may be between 19% (as in the IMF study) and 25% (as in the Alesina-Ardagna study).

Even if fiscal consolidation programmes have a reasonable chance of being accompanied by growth and employment creation, the latter cannot be attributed to budgetary austerity. Often, enabling factors more important than fiscal actions are at work, including: (1) the influence of the global business cycle, (2) monetary policy, (3) exchange rate policy, and (4) structural reforms.

Again, most of these 74 cases and 107 episodes occur after 1974, when it was exceedingly obvious that the economy was no longer in good shape. And all of then occur during or after 1970, when the economy was in fact no longer in good shape.

I like this paper's recognition that there are always other factors at work.

This PDF is short, and definitely worth the read.

Beckworth's third link brings up The Boom Not The Slump: The Right Time For Austerity, an 8-page PDF. This paper is a review of Alberto F. Alesina and Silvia Ardagna's 2009 paper, “Large Changes in Fiscal Policy: Taxes Versus Spending”. That is one of the papers also considered at Beckworth's second link. Again, the study considers only conditions since 1970 when the economy was already in trouble.

The paper's conclusion:

We are living in extraordinary times. This is the largest recession since the Great Depression. A large part of the rest of the world is also undergoing a sharp downturn. There is a genuine and reasonable concern that public intervention will replace the private debt overload with a sovereign debt overload. As such, sound policy advice requires that we recognize what historical examples are relevant for our current situation.

The A & A data do not appear to provide much solace in this regard. Their examples of successful consolidation are typically conditional on cutting a deficit during a boom and not during a slump. There may be situations in which consolidation does indeed result in better outcomes, but those do not apply to the U.S. at the moment. It is not clear that immediate fiscal consolidation will do much to alleviate that worry. Without robust growth, there is little hope of the debt-to-GDP ratio falling. The hope in undertaking such steps is for private investment to be reignited by increased trust and faith in the viability of government finances. While this may be a reasonable hope in some situations, the prospects for such a revival in the U.S. appear bleak.

Without robust growth, there is little hope.

These studies, and the studies they examine, consider events occurring during our time of troubles. If we want to escape from the troubles and from the crisis that came of them, we would do well to contrast troubled times to times of robust growth.

In addition, the studies consider public debt, which is not the debt that caused our troubles. If we want to achieve robust growth, we must not ignore private debt.

I examine the brief "macroeconomic miracle" of 1995-2000 in The Rise and Fall of the Non-Federal Relative. In that post I show that the short period of robust growth was indeed associated with accommodative monetary policy. I also show it associated with a fall in private debt relative to public debt. In other words, growth follows from the reduction of private debt. Not from the reduction of public debt.

The same trends -- a relative fall of private debt, and monetary expansion -- appear during the FDR years, and again in our time, since 2008.

After a period when private debt is reduced (relative to public debt), accommodative monetary policy encourages the renewed growth of private debt, and this leads to renewed economic growth. Such growth happened between 1947 and 1973. It happened between 1995 and 2000. And it will happen at some point in our future, unless we blow it. But when will it happen? That depends on the wisdom and folly of policymakers.

There are those who would reduce the private debt ratio by increasing the public debt. This can work, but only if private debt growth is somehow held back until the ratio has fallen. But it is inflationary.

There are those who would reduce the private debt ratio by allowing the economy to collapse. This can work also, and this is the way we are headed I think, but it will not be pretty. And it is deflationary.

It seems to me there is a middle ground, where to reduce the private debt ratio we reduce private debt by printing money and using that money to pay off debt. When you pay off debt, the debt ceases to exist, and so does the money you use to pay it. If the newly printed money ceases to exist, it cannot be inflationary. And if we manage in this way to avoid collapsing the economy, it will not be deflationary.

Without robust growth, there is little hope.


nanute said...

Have you thought about the reduction of private debt by shifting it to the public side via TARP and QE? I know you've been arguing that there is too much private debt. It would seem that all of the monetary policy to date has only addressed one sector of the private debt levels to the detriment and at the expense of the consumer class. Rewarding bad behavior by bad actors at the top of the ladder seems perfectly OK. Ignoring the engine that drives the economy is where the problem lies; I think.

Jazzbumpa said...

I got riled up at Roberts more than at Beckworth, but Beckworth is hidebound in his own way. As near as I can tell, he totally discounts the effectiveness of expansive fiscal policy. In fact, in the key sentence you quote, and further doen the post - he explicitly endorsed fiscal contraction as expansionary.

Fiscal and monetary policy need to work together. Each has the same goal - to get money flowing in the economy. As we see quite clearly now, pumping in money without other policy moves is not effective at the zero interest bound. But Beckworth says: "Another way of saying this is that an independent monetary policy will always dominate fiscal policy."

This is absolutist dogma, which looks to me like a very poorly backed up assertion. In fct, I think he has it close to exactly backward.

Here, nanute makes a good point.

There are those who would reduce the private debt ratio by increasing the public debt. This can work, but . . . it is inflationary.

No, it's not.

And if it were, we need some (core) inflation and we're not getting it. Instead, we get asset bubbles.

I'll make my own unfounded assertion: In a time that calls for fiscal expansion, monetary expansion does not stimulate the economy, but instead rewards rent-seeking. This can manifest itself as asset bubbles. These lead to headline inflation, but (in the current economic environment) do not transfer into core inflation because the secular inflationary trend is negative.


The Arthurian said...

Me: There are those who would reduce the private debt ratio by increasing the public debt. This can work, but . . . it is inflationary.

JzB: No, it's not.

Jazz, you always think in terms of the current crisis. In the remark you excerpted there, I was thinking about FDR's policy, which was *explicitly* inflationary. In addition, current Fed policy is *trying* to be inflationary.

The Arthurian said...

Nanute, I would not say TARP and QE shifted debt to the public side. I would say they shifted (toxic) assets to the public side. The debt, the toxic liabilities, remain in the private sector still.

The money they used for QE -- they should have taken that money and used it to pay off debt for people. Pay off the toxic liabilities, make them non-toxic and make them disappear, and make the toxic assets non-toxic at the same time. The money would have ended up in the same hands anyway: the hands of the creditors. And the liabilities that drag us down would have been lightened.

Definitely, the "consumer class" should have been included in the fix.

nanute said...

Well, the question is how much toxic assets did "we" purchase, and at what price? I'm pretty sure during QEI, any toxic asset purchases were at face value. If you think that those "assets" will pay off at par, then you are right. If not, then I would say it is a shift of liability to the public side of the ledger. The remaining toxic assets in the public sector can't be treated as liabilities until they are sold at less than face value. The suspension of mark to market has allowed the fiction to count these "assets" at par. I'd like to see them sold at that level. Furthermore, giving large amounts of cash to financial institutions and allowing interest payments on excess reserves is indirectly a shifting of debt to the public side from the private side. No?

Jazzbumpa said...

Jazz, you always think in terms of the current crisis.

Art, amigo, at the link, I looked at 100 years of data.


Jazzbumpa said...

The suspension of mark to market has allowed the fiction to count these "assets" at par.

I have no idea how important this - in and of itself - is in the grand scheme of things. But it is a very telling example of the hands-off, see-no-evil approach that we have taken in these anti-regulatory times.

Lax tax policies are a big part of our problem, lax regulatory policies might be even bigger - now, in the 30's and in the entire 19th century.


The Arthurian said...

Nute, I was going to let this go (because I don't know anything about accounting or bookkeeping) but now Jazz is quoting you and I think an error may be compounding.

"Asset" and "liability" are technical terms, and if I understand them:
An asset does not become a liability when it goes bad. It *seems* like a liability, to be sure, but it is still an asset, a bad asset or a "toxic" asset. The terminology is important because the liability going bad is what makes the asset go bad.

Using your phrasing, if those assets do not pay off at par, then the government purchase of them transferred RISK from private creditors to the government. But the LIABILITY remains with the homeowner struggling to make payments. Again, the terminology is important, because the government, rather than buying bad assets, should have paid off the bad liabilities. Pay off the mortgages that people cannot pay, before foreclosure strikes. The debts go away, the liabilities go away, the risk goes away, and the economy improves a bit as a result.

Our actual policies removed bad assets from the private sector, but left bad liabilities festering. And since it is the inability to meet one's liabilities that created the problem, the policies did not *begin* to solve the problem.

I'm really stickin my neck out here. I sure hope I have the terminology right.

Clonal said...

Art you might find this paper from the New York Fed interesting. It is about the FDR years - Great Expectations and the End of the Depression

Look particularly at figure 2.

nanute said...

Technically you are correct, and on that I concede the point. I keep getting stuck on the question of when does an asset become a "liability." When there is an expectation, or likelihood that it will not be repaid? Granted, it is still an asset in technical terms. I think it is safe to say that Assets minus Liabilities Equals Owners Equity. My point is that if you overstate assets on the balance sheet you are by definition understating liabilities. If as you say, the government bought a portion of the toxic assets but left the liabilities in the market all that has been accomplished is buying time. The question is how many of those liabilities still out there are tied to the very "assets" the government purchased? If we've already paid for them, they should be removed from the ledger. The problem is that in essence, the banks want to get paid twice.
On Clonal's link,(thanks), you will see that what Roosevelt did aside from creating positive expectations, is that he inflated the economy. If you are interested, here is an interesting working paper from the late Bill Vickrey on economic fallacies.
Pay close attention on what he has to say about inflation and employment.

nanute said...

I thought I left a lengthy reply earlier this morning. Did blogger eat it?
word verification: zaxes

The Arthurian said...

Yes indeed, Nanute. You got spam-filtered.

In response: I think you and I agree that the "fix" only tried to fix half the problem, and that wasn't very good.

"The question is how many of those liabilities still out there are tied to the very 'assets' the government purchased? If we've already paid for them, they should be removed from the ledger."

Yeah, I like that. If the Fed bought my mortgage and now I'm making payments to the Fed, they should just put my paperwork into the shredder and forgive my debt.

In exchange, I'll take my mortgage money and use it to stimulate the economy a bit -- perhaps by going out to dinner once in a while.